Aurora Borealis
1 November 2013 CFA Institute Journal Review

Why Are Stock Splits Declining? (Digest Summary)

  1. Ahmed Sule

The annual percentage of stock splits has been declining since the early 1980s. The authors examine the reason for the decline and determine that it is a result of changes in investor characteristics.

What’s Inside?

In this study, the authors investigate the factors contributing to the decline in the frequency of stock splits—that is, the percentage of firms that split their stocks in a given year. They also examine the firm-specific characteristics that make companies decide to split their stock. They explore the role that small investors play in firm decisions to split stocks by examining whether household income and household equity ownership are contributing factors to firms’ inclination to split stock.

In addition, the authors examine the relationship between institutional ownership of equity and a firm’s inclination to split stock. Finally, they investigate the trends in split factors (i.e., the ratio of the number of shares after the split to the number of shares before the split).

How Is This Research Useful to Practitioners?

Companies sometimes use stock splits to attract small investors, who are attracted by the lower prices. The frequency of stock splits increased from the 1920s to a peak of 23% in 1982. Since 1982, the frequency of stock splits has declined continuously, to less than 1% as of 2009. The authors examine the firm-specific factors that contribute to firms’ decisions to split stocks and note that firms with less valuable growth opportunities, a lower level of risk, lower stock liquidity, higher profitability, and higher share prices are more likely to engage in stock splitting.

In examining the drivers for the decline in firms’ propensity to split shares, the authors find a correlation between the drop in household equity ownership and the decline in the frequency of stock splits. They suggest that the increasing availability of institutional funds has encouraged small investors to diversify across a number of securities, thereby reducing the motivation for firms to split their stock to attract these investors.

The authors also investigate the contribution of small investors’ wealth to the declining propensity to split stock and discover that as household income increases, firms are less motivated to split stock because wealthier investors are more likely to afford stocks with high nominal prices.

In addition, they note that institutional equity ownership is negatively correlated with firm decisions to split stocks. The increasing institutional investor ownership of stocks has made firms less likely to split stocks because doing so results in additional costs to institutional investors, and the firms do not want to alienate these investors. Finally, increasing institutional equity ownership has also resulted in the decline of the ratio of the number of shares after the split to the number before the split since 1982.

How Did the Authors Conduct This Research?

Using the CRSP database, the authors examine the trend in stock splits using the sample period of 1926–2009. They then narrow their focus to the period of 1963–2009 to determine the contributing factors in the decline in the frequency of stock splits. They utilize data from CRSP and COMPUSTAT and use logit regression to analyze firms’ propensity to split stock, with institutional ownership, household ownership, household income, market return, stock price, trading range, and stock return as independent variables.

The authors also carry out additional robustness tests to verify the validity of their arguments, and the results of the test are consistent with their conclusions that stock splits are correlated with an increase in household income and a decline in household equity ownership.

Abstractor’s Viewpoint

The article will be beneficial to investors who want an understanding of the drivers of firm decisions to split stock beyond the generalizations provided by behavioral finance and the reasons behind the decline in the frequency of stock splits. Although this study reveals that the decline is a result of an investor-composition change, it would have been beneficial if the authors had also examined whether these trends are applicable in developed capital markets other than the United States.

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